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Ramesh Pathania/Mint
Ramesh Pathania/Mint

How EPFO’s equity hike will impact you

The provident fund body plans to double its equity exposure; subscribers would have to wait for at least 5 years to see how this will affect their EPF savings

For the current financial year, Employees’ Provident Fund Organisation (EPFO) will double its equity investment and invest 10% of the incremental corpus through the exchange traded fund (ETF) route. It is estimated that it will invest about Rs13,000 crore in ETFs.

An ETF is a basket of securities that tracks the stock of the companies on an underlying index, and it is traded on the stock exchange. Being a passive fund, it not only comes with a much lower expense ratio but also circumvents the fund manager risk.

EPFO invested in the stock markets last year for the first time, through ETFs, and even as the rules allowed it to invest up to 15% of incremental EPF corpus, it decided to be cautious and invest only 5% of the incremental corpus in the stock market. As it would be doubling its investment, let’s find out if the hike is big enough to make an impact on EPF returns.

About EPF

EPF is one of the top-recommended products in the debt space, to target long-term goals such as retirement. Not only can it generate a real return by beating inflation, it also comes with tax benefits.

Every month, a salaried individual contributes 12% of her salary in the EPF account and the employer matches the contribution. A part of the employer’s contribution goes to the Employees’ Pension Scheme (EPS). The contributions made to EPF then compounds at a rate declared by the EPFO every year.

Currently, the rate of interest is 8.8% but for FY17 the rate is yet to be decided. EPFO invested only in debt products primarily through government securities, and public and private sector bonds. Its entry in the stock market could improve long-term returns.

Entry into the ETFs

In August last year, EPFO picked two ETF schemes of SBI Asset Management Co. Ltd—SBI ETF Nifty and SBI Sensex ETF.

Then, EPFO had said that as the State Bank of India was its sole banker, it chose the schemes of SBI Mutual Fund as it didn’t have time to issue a tender and spend a year finalising an asset management company. This year it has UTI Asset Management Co. Ltd as the second fund manager.

Currently, UTI Mutual Fund manages 25% of the corpus, whereas SBI Mutual Fund manages 75% of the corpus. The split between Nifty and Sensex ETFs is 75% and 25%. Both come with an expense ratio of 0.069%.

Loose ends

But what remains to be seen is the manner in which the equity returns will be accounted for in the interest rate calculation every year. EPFO is supposed to declare a rate of interest at the beginning of the year, which is the rate at which your money will compound for the year.

This rate also needs to take into account returns from the equity market, and EPFO is still in the process of finalising its equity accounting policy. In December last year, EPFO came out with a circular explaining the method of accounting for equity investments, but it is not finalised yet and according to an EPFO official who didn’t want to be named, the circular is still under review.

Even if the returns are factored in, according to the official, the exposure is too little to make an impact. “For FY16, EPFO invested around Rs6,500 crore in ETFs as against a total corpus of Rs7.5 lakh crore (trillion). Till now the corpus is already at Rs8 lakh crore and if we invest Rs13,000 crore in equities, it will be less than 2% of the total corpus. The exposure is not big to impact returns in any significant way," said the official. However, once the exposure becomes significant it will throw up other challenges. “EPFO funds constitute about 65% of the EPF money and 35% of the EPS money. So a portion of the EPS money gets invested too. This certainly increases the risk as it brings in volatility in EPS, which is a long-term guaranteed product," said Manoj Nagpal, chief executive officer, Outlook Asia Capital.

What it means for you

You will have to wait a while to see the impact of equity in the ETF portfolio. According to Nagpal, even at a 10% exposure of the incremental corpus, subscribers will have to wait for another 5 years to see the impact.

For the stock markets though, more inflows from EPF is good news as it brings more long-term money, which lends it stability. “Globally there is trend of assets moving to passive management, which essentially means ETF investing. More money through the ETF route means that large-cap stocks are the beneficiaries, since indices are mostly focused on liquid and large-caps. However, as more money moves into ETFs, opportunity to create alpha shifts to non-ETF stocks," said Vikas Khemani, chief executive officer and president, Edelweiss Securities Ltd. As contributions in equity begin to increase over the long term, it should improve returns on your investments.

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